Markets are doomed. Again. Warnings of looming Armageddon have become routine over the last decade, so it wasn’t surprising to hear another apocalyptic forecast at the recent World Economic Forum at Davos.
"Guggenheim says market a 'ponzi scheme' that must collapse," headlined Bloomberg, following comments from Scott Minerd, the global chief investment officer of Guggenheim Partners. Loose monetary policy had inflated asset prices but investors would eventually "awake" to the rising tide of corporate bond defaults and downgrades, said Minerd. A "tipping point" will be reached and investors should expect a "severe" equity bear market with losses of 40 to 50 per cent. Guggenheim has more than $275 billion in assets under management and Minerd, a member of the New York Federal Reserve's investor advisory committee on financial markets, is widely regarded as a thoughtful, experienced money manager. In other words, he is not regarded as a perma-bear given to wild scaremongering.
Nevertheless, we’ve been here before. “Markets are on ‘collision course for disaster’, says Guggenheim’s Minerd”, headlined MarketWatch in March 2018. “Guggenheim investment chief sees a recession and a 40 per cent plunge in stocks ahead”, reported CNBC a month later. Near the bottom of last May’s minor market pullback, Minerd warned of a “much more severe downturn before the end of the summer”, with stocks likely going “somewhere below the lows” at the end of 2019.
Investors who followed this advice lost out – the S&P 500 quickly recouped its losses and ended 2019 with gains of 29 per cent, its second-best year since 1997.
Apocalyptic commentary
Minerd is obviously entitled to share his concerns and healthy markets have always been made up of a mix of bullish and bearish voices. Nevertheless, the sheer volume of apocalyptic commentary today is different, noted a November report by JP Morgan strategist Michael Cembalest.
“Something peculiar happened after the global financial crisis: the rise of the Armageddonists,” said Cembalest, referring to the variety of money managers and forecasters “whose apocalyptic comments spread like wildfire”.
Armageddonist commentary differs from money managers adopting a “defensive posture”, said Cembalest, in that the latter are conservatively dialling down their risk profile while the former are effectively calls for “wholesale reductions in portfolio risk” due to expectations of “recession, bear markets, financial crises and general mayhem”.
The report contains a table containing Armageddonist commentary dating back to 2010 from 17 different observers. The tone tends to be certain: in 2011, high-profile bear and Gluskin Sheff strategist David Rosenberg said he was 99 per cent sure of a recession by the end of the following year; the odds of a near-term global recession were "100 per cent", said Marc "Dr Doom" Faber in 2012; "I am 100 per cent confident the crisis that we're going to have will be much worse than the one we had in 2008," said money manager Peter Schiff in 2013. Some of the names on the list are widely perceived as investment cranks, although others are major figures. They include Jeffrey Gundlach, the billionaire bond manager who said in 2011 that it "seems suicidal" to buy stocks and who advised investors to "sell everything" in 2016. Legendary investor George Soros, who warned in 2016 that markets were facing a "serious challenge that reminds me of the crisis we had in 2008" is also there, as is billionaire investor Carl Icahn, who warned in 2015 of a "very massive bubble" and a "bloodbath".
The table of 17 names was "not an exhaustive list", said Cembalest, and it's easy to think of other major figures who could have been included. Billionaire investors like Bill Gross, Stanley Druckenmiller and Paul Singer have all issued dire warnings at various stages over the last number of years.
Think too of Larry Summers, the respected former US treasury secretary who was one of the favourites to replace Ben Bernanke as chairman of the Federal Reserve in 2014. Summers' warnings have become a perennial event, such as in 2015 ("As in August 1997, 1998, 2007 and 2008, we could be in the early stage of a very serious situation"), in 2016 (global economic risks are "as great as any time I can remember"), in 2017 ("markets and the economy are most likely enjoying a sugar high that will not last a year") and in August 2019 ("we may well be at the most dangerous financial moment since the 2009 financial crisis").
Opportunity cost
The point isn’t to poke fun at incorrect forecasters, but to consider the opportunity loss for investors who rotate out of risk assets and into bonds on account of such commentary. Armageddonists will eventually be “rewarded with a recession”, said the JP Morgan report, but the next downturn and bear market “will have to be quite severe to earn back what was sacrificed along the way”, requiring a “multiyear bear market with 35 to 45 per cent declines”. That’s unlikely, according to Cembalest. Yes, there are obvious risks – elevated valuations that are “well above” normal levels, a “disturbing” decline in underwriting standards in the leveraged loans market, rising political risk amid calls for greater regulatory scrutiny and substantial tax hikes, and large deficit spending late in the business cycle. This all suggests the chances of a “fundamental re-ordering of the US economy” are rising, but the overall picture indicates the next bear market is unlikely to be “as damaging or long-lasting as the ones in 2001 and 2008”. Bears who suggest otherwise may be guilty of what behavioural finance experts term base rate neglect.
When trying to estimate the odds of something, it makes sense to start with the base rate, or the average historical experience. US markets halved in 2000-02 and again in 2007-09, but you have to go all the way back to the 1930s to find the last time stocks more than halved in value. It could happen, of course, but history suggests the next bear market is unlikely to be that vicious.
Similarly, when assessing prognostications of serious market declines, investors should consider that while stocks don’t rise all of the time, they do rise most of the time. US stocks have gained in roughly three out of every four years, while British stocks have beaten cash in 69 per cent of two-year periods, 76 per cent of five-year periods and 91 per cent of 10-year periods.
Negativity bias
Following dire market forecasts tends to cost investors bucketloads of money, but the appetite for pessimism porn is large. Why? "Mega-bearish news" appeals to the human negativity bias documented by Nobel economist Daniel Kahneman and others, notes Cembalest. He cites research confirming the inverse relationship between magazine sales and the positivity of a magazine's cover as well as a 2014 experiment that found a city newspaper lost two-thirds of its readers on a day when it deliberately only published positive news. Financial writer Morgan Housel, now a partner at the Collaborative Fund, once noted how optimism "appears oblivious to risks, so by default pessimism looks more intelligent".
Not only that, “optimism sounds like a sales pitch, while pessimism sounds like someone trying to help you”. Both assumptions are seriously misplaced, but they’re widely held. As a result, the appetite for costly Armageddonist investment commentary is unlikely to dissipate any time soon.
